Santa Rosa office market steady as employers adjust post-COVID plans
Over the past 24 months, the utilization of office space has likely been at the lowest point in history, as employers shifted to remote working during the pandemic.
While utilization was low, the Santa Rosa marketplace remained steady in terms of vacancy. This is demonstrated by the fourth quarter 2021 vacancy being 12.7%, compared with fourth quarter 2020 vacancy of 11.6%. While this represents an increase in vacancy of 90 basis points and negative absorption of about 68,000 square feet, it should be noted that the north Santa Rosa corridor office vacancy reduced over this same period by 1 percentage point. That was positive absorption of 23,000 square feet.
The Sonoma County airport area incorporates a large portion of the of the north corridor submarket, and its vacancy is closely tied to that of central Santa Rosa.
As the COVID numbers have declined and masking requirements have been relaxed, we are seeing more employees returning to the office.
However, it appears that the lessons learned and hybrid work infrastructure that was put in place over the past few years may have changed the future of office space utilization. Employers seem more open to the idea of hybrid work and employees seemed to have embraced the flexibility provided by a hybrid strategy.
The office remains a pivotal piece to the equation, but we are starting to hear more companies question the amount of space they have given the number of employees utilizing the space. This certainly could have a negative impact on our vacancy rates as companies “right size” based on the number of employees coming into the office each day. Sublease vacancy remains an insignificant portion of the current vacancy, but many companies are adjusting their requirements as their leases expire.
Demand for office space has been sort of a mixed bag depending on the location and quality of the building. The highest quality buildings in the Stony Point Road and Fountaingrove Parkway areas have had fairly strong demand, while many in outlying areas or downtown have struggled to procure tenants.
We are currently seeing class A office properties in the best locations commanding rents of $2.25–$2.40 per square foot fully serviced. Class A rents outside of the most desired areas are in the $1.90–$1.95 range full service.
Office rents in older generation properties are in the $1.75–$1.85 per square foot full service levels. These rates are roughly in line with where they stood at the end of 2019 before the roughly 5%–10% decrease we saw throughout 2020 to 2021.
Lease incentives have been reduced over 2020-2021 levels but are still achievable, depending on the situation. Construction costs for tenant improvements continue to increase each year well beyond the increase in rental rates. This is squeezing the net income of investment properties.
As such, some owners are beginning to propose improvement allowances to cover a portion of the improvements with the tenant expected to pick up the balance vs. delivering spaces with “turn-key” improvements which has been the standard over the past years.
Owner-user demand has slowed slightly over the past 12 months. Pricing has held steady, but the inventory of buildings, especially those in the 1,500-3,000sf range, has increased. SBA and bank rates remain at historical lows which has kept pricing level over the past few years.
I believe the lower demand is fueled by the uncertainty of what the future of in-office work will look like. In most cases, purchasing remains the best option for companies to fix their occupancy costs which leads to long term savings, especially after tax considerations are taken into account.
Dave Peterson (707-528-1400, email@example.com) is a senior partner at Keegan & Coppin Co. Inc. in the Santa Rosa office.